GMP, Orion and Westwind on Discovery Air quarter
For those of you who have an interest in such things…”
Revenue in Q2/08 was $43.6 mm compared to $18.1 mm in the same period last year. These results were significantly ahead of year-ago levels as a result the company’s fleet expansion initiatives and acquisition growth. As a reminder, the company acquired GSHL on June 20, 2006. As a result, GSHL did not contribute on a full quarter basis in Q2/07. In addition, DA also acquired Air Tindi Ltd. (December 2006) and Walsten Air Service Ltd. (March 2007), both of which were not owned by the company in the same period last year. While revenue did increase significantly, reported revenue came in slightly below our estimate of $47.0 mm for the quarter.
Total flying hours increased by 88.4% to 29,834 hours from 15,837 hours the same period last year. This increase was the result of increased flight hours at both its Rotary Wing segment and its Fixed Wing Segment. The second and third quarters are historically the company’s busiest quarters due to seasonal factors (the company typically generates 75% of its annual revenue in these two quarters).
While revenue did come in slightly below our forecast, we view the reported revenue results positively. EBITDA came in at $18.7 mm this quarter versus $8.0 mm in the Q2/07. As discussed, the increase in results was attributable to the company’s ongoing fleet expansion and acquisition growth. These results were in line with our EBITDA estimate for the quarter of $18.9 mm. EBITDA margins this quarter declined slightly to 43.0% compared to 44.2% in the same period last year.
Discovery Air reported a net profit for the quarter of $10.1 mm or $0.09/share which was in line with our estimate of $9.8 mm or $0.09/share. These results were ahead of year-ago results of $4.4 mm or $0.07 per share (shares outstanding had increased to 110.9 mm from 58.0 mm in Q2/07).
We remain optimistic regarding the company’s prospects and have tweaked our F2008 estimates
slightly to take into account the slight revenue shortfall reported this quarter. However, our earnings estimate remains unchanged. We forecast DA will earn $11.8 mm or $0.10 per fully diluted share in fiscal 2008 and $20.2 mm or $0.15 per fully diluted share in fiscal 2009. Year-to-date, DA has generated earnings of $0.06 per share. While Q3 is expected to be strong, we remind investors that DA will likely report an operating loss in the fourth quarter due to the seasonality of the company’s business.
We are maintaining our BUY recommendation and target price of $2.10 per share. Our target price is based on an average of our fiscal 2009 P/E (15x) and EV/EBITDA (6.5x) valuations. We currently forecast that Discovery Air will earn $11.8 million or $0.10 per fully diluted share in fiscal 2008 and $20.2 million or $0.15 per fully diluted share in fiscal 2009. We believe that our earnings estimates are conservative and represent only a base case scenario for the company. The company’s strategy is to grow both organically and through strategic acquisition and we have not included any additional acquisitions into our forecasts. We believe that strategic acquisitions will create long-term shareholder value for the company as they will enhance operational efficiencies, expand the company’s geographic reach and reduce earnings seasonality.
At their current price of $1.60 we believe DA.A shares are undervalued.
What Happened?
• On Thursday morning Discovery reported strong Q2 results. EPS and CFPS came in at $0.09 and $0.13, respectively. Both numbers were broadly in line with our forecast (we were looking for $0.10 and $0.13) and up nicely year over year. Impressively, this performance was achieved in spite of an unusually quiet forest fire season in Ontario through June and July.
What Does it Mean?
• Confirmation of Discovery’s earnings power. As we have discussed in the past, this is a highly seasonal business. In fact, prior to the acquisition of Top Aces, we estimated that about 75% of the business’ annual revenue would be generated between May and October.
As such, and given a cost structure that includes a reasonable amount of fixed overhead,
bottom-line performance will vary materially depending on the quarter. Through the first half
of F2008 (one strong quarter and one weak quarter), Discovery has generated $0.06 in EPS
and $0.11 in CFPS. We expect a similar performance through the back half of the year.
• Pricing/activity remains firm in the company’s northern-based businesses. During Q2, Great Slave Helicopters managed to show a 17.8% organic improvement in hours flown relative to last year and Air Tindi held in well despite a reasonably healthy ice road season that extended into May. We continue to believe that pricing increases in the mid-single-digit range are being realized (adjusting for business mix factors), and management suggested on the conference call that both businesses are off to a good start in Q3.
• Growth plans for Top Aces beginning to unfold. Specifically, the company has set its sights on adding to its Alpha Jet fleet in response to demand from both sides of the border.
We believe there are less than a dozen of these jets left on the global market and management
made it clear on the conference call that it is actively evaluating procurement options. Conservatively, every two to three incremental jets could add about a penny in EPS all in.
What Is it Worth?
• DCF-based target stays at $2.60. While we have made some minor changes to our forecast,
our general thesis remains very much intact. At 9.8x our F2009 EPS estimate of $0.16 and
6.0x EV/EBITDA, we continue to believe that the stock represents good value relative to its
peers, which average 13x and 6.6x, respectively. There could be upside to our numbers should
Discovery prove successful in securing additional Alpha Jets (or other training aircraft).
What to Do
• Good quarter; maintain Overweight position. The Top Aces acquisition adds another exciting growth platform to Discovery’s portfolio and we believe investors should own this name ahead of further business developments.
Insight or Development
Discovery Air (DA) reported strong Q2/08 results in line with our expectations and consensus – revenue was $44 MM, EBITDA was $18.7 MM and EPS (F.D.) was $0.09 (versus our estimates of $46 MM, $19.5 MM and $0.09, respectively).
Expectations were high this quarter, and strong results, despite softness from Hicks & Lawrence (H&L), should increase investor confidence in the company’s profitability going forward.
Analysis
As expected, Q2/08 was seasonally strong. Great Slave (GSHL) and Air Tindi (ATL) benefited from the summer activity in Northern Canada, with GSHL experiencing organic year-over-year growth in hours flown (and therefore revenue) of ~18%. Air Tindi’s performance also exceeded budgeted expectations, but H&L experienced a ~40% decline in flying hours on a year-over-year basis, due to the increased rainfall in northern Ontario and the subsequent reduction in the number of forest fires, especially during the months of June and July.
Overall hours flown, including strength at GSHL, moderate growth at Tindi, and a decline at H&L were up 4.4% Y/Y; but we believe the company will achieve double-digit growth on a go-forward basis once H&L returns to normal. Corporate expenses were $1.3 MM compared to our $0.9 MM estimate and were the primary reason for our EBITDA variance. Excluding one time expenses of ~$0.5 MM, Q2/08 EBITDA would have been $19.2 MM. The overall seasonal strength was also evident in the company’s EBITDA margins which were 43% in Q2/08 compared to (5%) in Q1/08.
Management indicated that ATL was in the process of negotiating a new three year contract with DeBeers to provide aviation services for the Snap Lake diamond project. With the project scheduled to begin production this year, we expect to see an increased demand for regular air transportation services to and from the site. If the new contract were to be signed, ATL should see an increased demand, especially for its Dash 7 aircraft. DA also reaffirmed that Top Aces was exploring the possibility of providing air combat training services to other NATO allies. While we have not included any upside potential from the above developments, such contracts would likely provide for upside from our forecasts. DA also announced the extension of ATL’s Medevac contract which has been in place for approximately 14 years.
There are no material changes to our FY2008 forecasts. Due to updated 2009 revenue guidance from Top Aces, we have increased our FY2009 revenue estimate for Top Aces to $35 MM (from $27 MM). As a result, our overall FY2009 revenue and EBITDA estimates have been moderately increased to $168 MM and $53 MM (from $160 MM and $50 MM). Although the
EBITDA increase is partially offset by interest on additional debt assumed from Top Aces, our 2009 EPS estimate increases to $0.17 (from $0.16).
Conclusion
While our $2.25 target is unchanged, this quarter has increased our confidence in DA’s high growth potential. A number of potential growth opportunities could provide upside from our forecasts going forward. Although the company has partially recovered from the recent sell-off, we believe that there is more room for stock price appreciation. We reiterate our BUY rating on Discovery Air.
MRM
(disclosure – Wellington Financial Fund II and certain managers/LPs own shares in DA.A as a result of the acquisition of portfolio co. Top Aces. I also own some conv. debs.)
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